Kleinwort Hambros writes:
It is easy to make sense of this juxtaposition with the benefit of hindsight. Risk assets outperformed in 2019 for two main reasons: one, as central banks signalled more stimulus to keep a sputtering economic expansion intact; two, trade war fears receded as US and Chinese negotiators appeared to have closed a “phase one” trade deal. Yet, as global economic activity generally slowed and geopolitical risks rose, investors simultaneously turned towards government bonds and gold.
Indeed, markets begin 2020 in a similarly contradictory state. The US and China are expected to begin work on “phase two” trade negotiations, but they are likely to be more difficult than those which occurred last year. Even so, even the success of “phase one” provided much-needed hope for the world’s manufacturers, who noted worsening conditions through most of 2019 before confidence began to stabilise in the fourth quarter. Nonetheless, the world economy remains fragile, with growth low, and inflation muted. Moreover, in early January, a sudden escalation of tensions between Iran and the US was an important reminder that unknown and unexpected risks can manifest themselves suddenly, even as the impact of this particular event appears to have been rapidly digested.
In the UK, expectations are for another choppy year of negotiations between it and the European Union. This is clear from the post-election surge in Sterling having dissipated rather quickly; it hit $1.35 in the immediate aftermath of the results but fell right back to $1.30 the following week. The realisation rapidly dawned that the election merely signalled the beginning of negotiations surrounding the future relationship with the EU, not the end. However, the Prime Minister has pledged to open the fiscal taps, which should help boost aggregate spending and unblock pent-up corporate capital expenditure. This may well raise real growth prospects, which in turn should push still undervalued Sterling to between $1.35 and $1.40.
Central bankers remain critical to risk assets. The European Central Bank has pledged to keep key rates on hold this year, as should the US Federal Reserve. The asset purchase programmes which both relaunched in late 2019 are likely to ensure that financial conditions remain extremely easy. The Bank of England’s next move is more uncertain – it may well cut rates or raise them – but it will be biased to keeping economic growth positive. There is evidence fiscal policymakers will be more active around the world – this could prove a game-changer.
Bottom line
We are keeping our overall asset allocation unchanged, having increased exposure to equities in December. All else equal, equities should see another year of outperformance over government bonds and cash, though returns will likely be much more modest than last year given higher starting valuations. Within equity markets, we maintain overweights on both the US and the UK, albeit for different reasons. We also have allocations to High-Yield credit and Emerging Market debt; they offer a reasonable yield pickup considering the low probability of recession. Nonetheless, risk-on assets can move negatively with staggering speed. This is why we maintain sizable allocations to safe-haven government bonds and gold.
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